A cost driver is an activity that explains resource consumption, such as machine hours, production units, setups or inspections. Variable cost behavior describes how total cost responds to that driver during a specified period.
The relevant range is the activity interval within which the stated cost relationship remains valid. A monthly factory lease remains fixed within existing capacity, but another production line can change the relationship.
Monthly cost behavior within 1,000 to 2,000 units follows.
Fixed costs remain constant in total within the relevant range and period. To calculate fixed cost per unit, divide the period's fixed total by the applicable activity; increasing output spreads the same total across more units.
Variable costs change in direct proportion to activity, while their unit rate remains constant under the stated assumptions. The materials calculation is 1,500 units x $8 per unit = $12,000.
Mixed costs contain both a fixed component and a variable component. Monthly maintenance at 1,500 units is $4,000 + 1,500 units x $3 per unit = $8,500; $8,500 divided by 1,500 units rounds to...
Common mistakes
- Selecting cost extremes. Using Neral's $11,000 month instead of the highest-activity month contaminates high-low with an unusual repair; the supported variable rate is $3 per hour.
- Blending incompatible process schedules. Dividing FIFO's $8,500 current material cost by weighted average's 5,000 equivalents produces $1.70, an unsupported hybrid rate.
- Using actual hours for application. Sorven's 550 hours x $10 applies $5,500 fixed overhead and incorrectly yields $500 volume variance; the standard allowance produces $1,000.
Bottom line
- Fixed costs remain constant in total within the stated range; variable costs remain constant per driver unit, while mixed and step costs require separate treatment.
- Accumulation, overhead allocation and inventory treatment are independent costing-system choices.
- Weighted average combines opening and current process costs; FIFO isolates current work and carries opening costs separately.
- Joint costs support inventory allocation, while further-processing decisions compare incremental revenue with separable future costs.
Exam shortcut
Identify the period, relevant range, output measure and required decision before selecting a formula. Mark whether the stem asks for total cost, unit cost, inventory, revenue or contribution. For process costing, reconcile physical units first. Mark material-entry timing and the stated flow assumption before calculating equivalents. For variances, calculate standard inputs allowed from actual output. Check whether materials price variance uses purchases or consumption, then preserve the sign convention.
The full lesson (about 11,044 words, 74 min read) adds 6 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- I.A3
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